- Currency futures are priced in the same manner as currency forward contracts.
- Price of a Currency Future with Simple Compounding:
f(0,T)X/Y = S0,X/Y ((1+rX)/(1+rY))T
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T = total contract length
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S0 = Spot exchange rate for X/Y (#X units domestic per 1Y foreign) at initiation
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rX = Risk free rate in country X (domestic currency)
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rY = Risk free rate in country Y (foreign currency)
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Price of a Currency Future with Continuous Compounding
f(0,T)X/Y = (S0,X/Y e-ryT ) erxT
- If the currency future is not "fairly" priced (i.e. not priced based on an arbitrage relationship based on risk free rates), then it is possible for a trader to earn a risk-free arbitrage profit.
- Futures Market Overvalues a Currency:
- Sell the overvalued futures contract
- Buy the underlying currency in the spot market
- Borrow and invest all cash flows
